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Agenda. Collect reaction papers multiple choice questions class participation forms for day 3 (Tuesday) Discuss Sunder Lev SEC readings. Spreads. What’s a spread? the difference between the bid (buying) and ask (selling) prices set by the market maker.

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Agenda

Agenda

  • Collect

    • reaction papers

    • multiple choice questions

    • class participation forms for day 3 (Tuesday)

  • Discuss

    • Sunder

    • Lev

    • SEC readings


Spreads

Spreads

  • What’s a spread?

    • the difference between the bid (buying) and ask (selling) prices set by the market maker.

  • A spread is positive when ask > bid and negative when bid > ask

  • Size of spreads reflects

    • extent of information asymmetry

    • cost of holding inventory

    • return to market makers’ human capital


Agenda 4122881

The effect of spreads on volume and prices

$

Demand

Supply

Ask

deadweight loss

P*

Bid

Volume

Q**

Q*

Quantity purchased = Quantity sold


Agenda 4122881

Setting spreads to build inventory

$

Demand

Supply

Ask

P*

Bid

Volume

Q

Q

Q*

S

P

Quantity purchased > Quantity sold


Agenda 4122881

Setting spreads to cut inventory

$

Demand

Supply

Ask

P*

Bid

Volume

Q

Q

Q*

P

S

Quantity sold > Quantity purchased


Agenda 4122881

The effect of information asymmetry on demand and supply

$

Demand

Supply

Ask

P*

Bid

Volume

Q**

Q*

Quantity purchased = Quantity sold


Agenda 4122881

Lee: 1

  • Accounting is an artifact of civilization: it exists to serve human needs

  • Accounting activity is a social system

    • objectives are defined by social needs

    • carried out by specialized agents (professionals in modern terminology)

    • education and training requirements keep increasing as objectives become more complex and sophisticated

    • rights and obligations of agents defined by society


Agenda 4122881

Lee: 2

  • Business became more complex, more sophisticated concepts were needed: what attributes to measure?

    • What’s the goal? Decision making vs. performance evaluation vs. stewardship

  • With separation of ownership and control performance evaluation (profit earned) became crucial -- focus shifted to I/S.

  • Stewardship still important -- B/S retained.

  • Accrual accounting seen as incomplete, Cash flow statements acquire usefulness


Sunder 1

Sunder: 1

  • Accounting standards are political in nature, redistribute wealth and are costly to society.

  • Standards are costly

    • need a bureaucracy

    • bureaucrats’ incentives may be “wrong”

    • standards stifle innovation, preserve status quo.

  • Neither pure cost-benefit analysis nor Pareto-optimality is likely to be a useful crieterion on its own.


Sunder 2

Sunder: 2

  • Optimal level of standard setting trades off both the total costs and benefits as well as the distributional impact of standards.

  • What standards would be best requires good information on costs and benefits -- can standard-setter learn these truthfully?

  • Multiple mechanisms exist to set standards

    • common law, markets, referendum, legislation, judiciary, bureaucracy


Sunder 3

Sunder: 3

  • APB was responsive to user needs

    • “lack of independence” seen as a virtue

  • FASB is seen as an aggressive, overly active, costly, entrenched bureaucracy with a built-in “bias for action” and is losing support from key constituencies

  • Slow down standard setting. Markets will deal with many issues without need for standards.


Lev 1

Lev: 1

  • Equality of opportunity for all investors is key to a well-developed capital market

  • Equality of opportunity comes from equitable distribution of information

  • Inequity is costly: cost of capital goes up as investors seek to protect themselves. Lower volume of capital supplied and demanded. The economy as a whole is worse off.


Lev 2

Lev: 2

  • Why mandate disclosure?

    • reduce costs of information asymmetry

    • voluntary disclosure incentives inadequate (?)

  • How decide what to mandate?

    • information that investors value

    • management earnings forecasts or information that is valuable for predicting future payoffs

    • information large investors or bankers get

    • protect the interests of the least informed


Lev 3

Lev: 3

  • How to measure disclosure effectiveness?

    • reduction in spreads,

    • increase in price informativeness

    • reduced returns to insider information

    • equalization of returns across comparable trading strategies


Sec chapter 1 1

SEC: Chapter 1 (1)

  • SEC charter: Securities acts of 1933/34

  • 33 Act: distribution, 34 Act: trading

  • Mandate: protect investors

  • Why regulation to protect investors?

    • (Lev vs. Sunder?)

  • Financial abuses preceding (and thought to have contributed to) 1929 crash.

  • Increased direct access to investors by firms.


  • Sec chapter 1 2

    SEC: Chapter 1 (2)

    • How? Regulate disclosure not merits

    • Why? Allow innovation, EMH.

    • Structure of the SEC?

      • operational arms are called divisions

        • corporate finance, investment management, market regulation, enforcement -- lawyers

      • staff are organized in offices

        • office of chief accountant, economist, general counsel -- these are the lawyers’ accountant, economist and lawyers respectively.


    Sec chapter 1 3

    SEC: Chapter 1 (3)

    • How the SEC speaks:

      • FRRs (financial reporting releases) -- binding

      • AAERs (accounting and auditing enforcement releases) -- who’s been naughty and what their punishment will be.

      • ISRs (international series releases) -- all about them furrin’ firms and furrin’ markets.

      • SABs (staff accounting bulletins) -- interpretations, not official positions of the SEC.


    Sec chapter 2

    SEC: Chapter 2

    • Understand the arguments for and against raising capital from the public (going public).

    • Steps in the registration process and obligations of underwriters and management at every step. Especially note the restrictions relating to the quiet period.

    • Who or what is exempt? Know this.


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